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Country Commercial Guides for FY 2000: Chile Report prepared by U.S. Embassy Santiago, released July 1999

CHAPTER II.   ECONOMIC TRENDS AND OUTLOOK

Major Trends and Outlook

Although Chile's economy has expanded continuously for the last decade and a half (annual average GDP growth in the 1990's has been better than seven percent), 1998 witnessed a slowdown that continued into 1999. The country's economy entered a technical recession by posting successive quarterly declines in year over year growth starting in the final quarter of 1998 and continuing in the first two quarters of 1999. Because Chilean growth has been led by a boom in exports, concentrated in primary products and processed natural resources (principally copper, fresh fruit, and forestry and fisheries products), the world economic slowdown and consequent decline in commodity prices have affected the country's growth trajectory. Perhaps even more importantly, tight monetary policy in 1998 in response to a growing current account deficit greatly contracted demand. The Government announced a package of tax and public works measures designed to stimulate the economy in June 1999.

Soaring investment, both foreign and domestic, sparked the export boom of the 1990's; although foreign investment continued strong in 1998, domestic investment slowed due to the monetary tightening. Both the product mix of and the markets for Chile's exports are becoming increasingly diversified, with dependency upon copper declining and Latin America joining the U.S., Asia, and the European Union as important purchasers of Chilean products.

The strong job creation and attendant decline in unemployment (which had fallen fell to 5.5 percent by mid-1998) of the last several years reversed later in 1998 as growth slowed. As of mid-1999, the national unemployment rate had risen to 8.7 percent as a result of the recession. The growth in real wages of better than five percent annually that occurred in the middle of the decade slowed somewhat, but remains positive. Inflation has declined gradually since 1990, ending 1998 at 4.7 percent. The surge in foreign investment that helped keep Chile's balance of payments positive for most of the 1990's was insufficient to avoid a decline in international reserves in 1998. Despite the successive financial crises in Asia, Russia and Brazil from late 1997 to early 1999 that led to a general lack of confidence in emerging markets, Chile's credit rating remains the best in Latin America. Since Chile first received an investment-grade rating in 1992, Chilean firms have raised funds abroad -- through borrowing, selling bonds, and stock issues -- to finance investment. The government is paying down official debt.

Chile's economy grew by 3.4 percent in 1998, an annual rate that masks the year-over year decline of 2.8 percent registered in the final quarter of the year (the economy posted a further decline of 2.3 percent in the first quarter of the 1999). The Central Bank of Chile has reduced 1999 growth projections on two occasions since presenting its annual estimate to the Congress in late 1998, and expects the economy to expand by just 0.5 percent in 1999 (under this scenario, the economy would be growing at a rate of five percent by the final quarter of the year). The Government announced a package of tax and public works measures designed to stimulate the economy in June 1999. Inflation should be in the 4.0 to 4.5 percent range. Growth is expected to accelerate during 1999 as international demand grows and world commodity prices harden. The 1998 trade and current accounts produced deficits totaling $2.5 billion and $4.5 billion, respectively (the current account deficit was the equivalent of roughly 6.3 percent of GDP). High foreign currency reserves and foreign investment flows continued to render the current account deficit level manageable. Moreover, greatly reduced demand for imports should mean that the current account deficit in 1999 will drop below four percent.

The decline in international investor confidence in Latin America after the successive financial crises from late 1997 to early 1999 initially impacted Chile, but a strong reduction in domestic demand induced by the monetary authorities and fiscal belt-tightening by the government helped restore it. Chile's high domestic savings rate (fostered in part by mandatory retirement contributions administered by private pension fund management firms) continued to ameliorate dependency on short-term foreign capital to finance investment. Because foreign investment in Chile is mostly direct investment, it is not likely to flee the country in response to temporary bad news. Chile's high rate of investment (gross capital formation in 1998 equaled 31.7 percent of GDP) means that production is likely to continue growing rapidly over the next several years.

Of total 1998 government revenue, 75 percent was derived from tax revenues, seven percent from operational revenues, some six percent from social security contributions and the remaining 12 percent came from other sources. Of overall tax revenues, the most relevant were: Value Added Tax (35 percent), income taxes (32 percent), taxes on specific items such as cigarettes (11 percent), and import duties (eight percent). State enterprises generated the remaining tax revenue.

Chile's reliance on exports and desire for market diversification have led it to seek opportunities to further open several current or potential markets. Chile joined the Asia Pacific Economic Cooperation (APEC) organization in 1994. It has signed bilateral trade-liberalizing agreements with a variety of Latin American nations, and free trade agreements with Mercosur and Canada. Chile and the European Union plan to commence exploratory trade talks in mid-2000, and Chile is an active participant in the negotiation of the Free Trade Area of the Americas (FTAA).

Principal Growth Sectors

The principal growth sectors for 1999 and the medium term are likely to be energy, telecommunications, construction, mining, and financial services. The mining, telecommunications and forestry sectors have benefited from major investments by foreign, including U.S., companies.

Government Role in the Economy

Businesses in Chile are predominantly owned and controlled by private interests. Prices, except those of regulated utilities, are set freely. Although the military and democratic governments of the last twenty years have privatized many state corporations, the state retains holdings in several industries. The most important public corporation is CODELCO, the world's largest copper company, which the government has said it will not sell. In 1994 and 1995, the Frei administration sold the government's remaining share in an airline and its electricity, shipping, and radio holdings. The majority of new highway projects, and port and airport infrastructure, are being built under a private concession program.

The public sector budget is approximately 22 percent of GDP. Important sources of tax revenue are the 18 percent value-added tax, personal income taxes, corporate taxes, and import tariffs. The top marginal personal income tax rate is 45 percent on income above $75,000. The government generally runs budget surpluses of around two percent of GDP (though the surplus was less than one-half percent of GDP in 1998), but these are balanced somewhat by losses of the independent Central Bank.

Balance of Payments Situation

Chile's international reserves, $16.6 billion as of end-May 1999, represent better than one year's worth of imports. For the last several years, capital inflows have more than made up for current account deficits. Due to continued surging domestic demand that increased imports substantially in 1998, monetary policy sought to reduce pressure on the country's current account by tightening real interest rates substantially (at one point, inter-bank lending rates were ratcheted up to 14 percent in real terms). The trade deficit grew to $2.5 billion in 1998 (current surplus of $1.2 billion for first half of 1999) and the current account deficit to $4.5 billion (or 6.3 percent of GDP). The lag effect of this policy of monetary tightening has been registered in a continued decline in imports that has substantially reduced pressure on the current account; most observers expect the current account balance to improve to a level below four percent of GDP in 1999. Due in particular to strong investment flows, current account deficits of this level are sustainable.

Infrastructure Situation

The Chilean government has targeted the highway network for more, mostly private sector, investment. With the government awarding over $1 billion in road concessions to allow private firms to build and manage toll roads, the Pan-American Highway, the major north-south route, is in good condition, but mostly at capacity. Concessions either have been awarded or are in the process of being awarded for the most heavily used 1,000 miles of the Pan-American Highway, from La Serena to Puerto Montt. There are adequate roads in many areas, but many secondary highways are unpaved, and there are some serious bottlenecks, particularly in urban areas.

Many international airlines operate from Santiago's airport, linking Chile with the United States and Europe. A number of adequate airports are located throughout the country. The government is upgrading many regional airports and expanding the international airport in Santiago through awards of concessions to private companies. Two privately owned Chilean airlines operate nationwide and link Chile with many foreign countries. Smaller regional airlines are also beginning to impact domestic air travel.

Major ports are located on the Pacific Ocean, the principal one being Valparaiso, which is about 80 miles (130 kilometers) from Santiago. Others are Arica, Iquique, Antofagasta, San Antonio, Talcahuano, and Punta Arenas. Foreign and local shipping lines cover the international traffic, whereas the coastal traffic is handled by several local companies, one of which is state-owned. Recognizing that the port facilities are largely inadequate for the growing and changing nature of Chile's trade, the government plans to award service and management concessions for the ports. Legislation authorizing port concessions was passed by the Chilean Congress in December 1997.

Telecommunications are excellent, and Chile has one of the best networks in the hemisphere. Cable, fax, telephone and Internet service rival those found anywhere in the world. The phone system is completely digital. There are eight international long distance carriers and three cellular telephone networks. Personal communication system (PCS) telephones were introduced in early 1998. Several Internet service providers supply the ever growing demand that has positioned Chile as one of the Latin American markets with the fastest Internet growth rate.

The Santiago subway has been in operation since 1976. It is efficient and well-maintained, and its third line was completed in April 1997.

Chile's railroad system, the fourth largest rail network in Latin America (5,511 miles, or 8,870 kilometers), urgently needs to be upgraded and expanded. The railroads are mostly property of the state-owned company "Ferrocarriles del Estado." The government plans to auction to private firms the right to operate the company's passenger service. There are two railroads connecting with Bolivia, one of which is privately owned.